ANALYSIS: Challenges facing Spohr in Lufthansa's top job

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Carsten Spohr’s standing as Lufthansa’s next chief executive will depend on delivery of his predecessor’s Score restructuring programme and follow-up initiatives. But perhaps the bigger challenge for the German carrier will be to accept that success on crucially important long-haul routes to Asia seems to hinge on partnership with Lufthansa’s more agile competitors in the Middle East and Turkey.

The timing of Christoph Franz’s departure in May – after just one term in office, and in the middle of his signature cost-cutting and revenue improvement programme – is ironic, as he is leaving at a point when it should become clear whether Score can meet its target. A year after he took the helm, Franz launched Score in 2012, with the intent of boosting the group’s operational profit to at least €2.3 billion ($3.1 billion) by 2015, from €820 million in 2011.

The result fell to around €520 million in 2012, and Lufthansa expects 2013 operational profit to come in at €600-700 million. “The baseline has lowered and the time period [left to reach the target] has shortened,” says Oliver Sleath, European airlines analyst at Barclays Capital. Project and restructuring costs, such as severance payments for redundancies, meant that profits would improve toward the end of the Score programme instead of the initial phase. Nevertheless, Sleath expects that 2014 will become a “critical year in terms of how achievable that €2.3 billion target really is”.

Thus far, high oil prices and strong competition on routes to Asia have brought Lufthansa under pressure. “If they continue to experience the same levels of headwind as in 2012 and 2013, then I think they will have to back away from that target... It really will be a test for Spohr,” says Sleath.

Since September 2013, when he revealed his unexpected plans to join Swiss pharmaceutical giant Roche, Franz has called on his successor to continue Score’s focus on efficiency improvement as a permanent ingredient in Lufthansa’s business. Employees have been disappointed about Franz’s sudden departure in the middle of the painful restructuring process, and hope that relations with management improve with the change at the airline’s helm.

Spohr was at the centre of Score as head of Lufthansa’s passenger airline and Franz’s deputy chief, but Christine Behle, senior executive of German service union Verdi, has told local media that staff expect the new chief executive to pay “significantly more attention” to their interests than his predecessor, and the head of flight attendant union UFO, Nicoley Baublies, has reportedly called on Spohr to engage in an “intensive dialogue” with the workforce.

Meanwhile, Lufthansa’s pilots are balloting about possible strike action after negotiations over a new labour agreement have led to no result for two years. The results of that ballot will not be published until 21 March – six weeks before Spohr succeeds Franz on 1 May – to give management “enough time for a change of course”, says pilot union Vereinigung Cockpit.

A leadership change could reignite the stalled negotiations. “Especially in something like labour discussions, a new [chief executive] might be able to make a name for himself,” says Frank Schwope, analyst at NordLB. However, Schwope agrees that it will be a key challenge for Spohr not only to complete the Score programme, but to continue the efficiency improvement strategy beyond 2015. The appointment is “not a bad change” as the new chief might be able to give Lufthansa’s transformation “new impulses”, says Schwope.

In the short-haul arena, Lufthansa’s challenges are set to continue after the carrier transferred all European traffic outside its Frankfurt and Munich hubs to low-cost subsidiary Germanwings last year. While the move should save €200 million until 2015 and return the loss-making short-haul operations to profitability, it remains to be seen how successfully Germanwings can compete against airlines such as EasyJet, Norwegian and Vueling. “It is unclear whether the new Germanwings is actually competitive against other low-cost carriers,” says Sleath.

While Lufthansa is protected at its Frankfurt and Munich hubs due to the large proportion of transfer passengers, strong route network and comparatively high airport charges, the challenge will be for Germanwings to fight its corner in secondary yet valuable markets such as Berlin, Dusseldorf, Hamburg and Stuttgart.

These are typical destinations where, in other countries, low-cost carriers have expanded by taking market share from the incumbent legacy airlines. While EasyJet and Ryanair have gradually expanded their presence in Germany over the past decade, Sleath says there has not been a “widespread assault” by budget airlines in Lufthansa’s home market yet. But he adds: “I do think that will happen in Germany in the medium term unless Germanwings can achieve a better cost base.”

Spohr’s biggest challenge will be to position Lufthansa in the long-haul arena, especially on Asian routes, as the market’s centre of gravity has shifted to the Middle East. A partnership with a Gulf carrier or Turkish Airlines looks to be the answer. But with Qatar Airways having joined Oneworld and Etihad Airways co-operating with Air France-KLM, this leaves only Emirates alongside Turkish as potential partners.

A tie-up with Emirates would be a surprising change of tack for Lufthansa given how outspoken it has been against the Gulf carriers. But if the German carrier wanted to co-operate with Turkish, it would need to rebuild the bridges it burned last November when Lufthansa unilaterally called off the codeshare agreements with the Istanbul-based Star Alliance partner and devalued the latter’s frequent-traveller bonus miles.

Turkish would be the more “natural” fit for Lufthansa and “more calculable” than Emirates, says Jürgen Pieper, analyst at private bank Metzler in Frankfurt. Sleath agrees that joining forces with the Istanbul-based carrier would be a better solution, because “Turkish is actually the bigger threat” than Emirates. “Turkish is either a close partner or a big enemy for Lufthansa,” he says.

While Emirates has been limited to flying to a maximum of four airports in Germany – currently Dusseldorf, Frankfurt, Hamburg and Munich – under the country’s bilateral agreement with the UAE, Turkish is flying to 12 airports in Lufthansa’s home market with quasi-unlimited access. These include regional destinations such as Bremen, Friedrichshafen and Nuremberg. Furthermore, while Emirates has to operate widebodies for flights from Dubai to Germany, Istanbul is close enough to deploy narrowbodies, which allow the targeting of markets with lower traffic volumes.

This is particularly significant in Germany, which is less centralised around few cities than, for example, France or the UK. Lufthansa in turn depends on those regional markets as the majority of passengers at its Frankfurt and Munich hubs are travellers on connecting flights.

However, co-operation with Turkish or Emirates would be a humbling step for Lufthansa, especially after the fallout with the former carrier last year. “I think it is a challenge for Lufthansa to accept that the world is changing and they need to be more open to co-operation either with the Gulf carriers or Turkish Airlines,” says Sleath. Pieper agrees that such a move will be difficult, because it will not only be a reversal in rhetorical terms – Lufthansa will have to learn to play a different part, too.

In previous partnerships and the establishment of Star Alliance, Lufthansa was in senior roles, and this seems to have manifested itself in the carrier’s self-conception, says Pieper. However, neither Turkish nor Emirates will accept a junior position in a relationship with Lufthansa now. After the row in November, Turkish’s chief executive Temel Kotil said Lufthansa’s move would have little effect on his carrier’s business. “We are happy alone,” he said, sardonically adding that Star membership was just the “icing on the top” of its own growth potential.

Lufthansa needs to strike a new tone with his competitors, for which the leadership change will be a welcome opportunity. Spohr is seen as more jovial than his rather sober and arguably more brusque predecessor Franz. This could help pave the way to a new partnership sooner than later. Sleath thinks that Lufthansa needs to find a solution within a year.